by John Darer CLU ChFC MSSC CeFT RSP CLTC
Investors in structured settlement payment rights may not receive an IRS Form 1099 from the life insurance company that issued the underlying annuity, even though there has been a direct assignment of structured settlement payment rights. This does not mean that no taxes are due.
The question arose when an investor contacted New York Life and was told that they would not receive a 1099, by a representative in the New York Life customer service department. The underlying structured settlement payments were (1) payments for worker's compensation under IRC 104(a)(1) payments, or (2) for damages on the account of personal physical injury or physical sickness. However, the income tax exclusion under IRC 104(a)(1) or IRC 104(a)(2) would only apply to the initial payee and their named beneficiary. It does not apply to the investor.
Despite the sometimes intellectually dishonest marketing by firms selling assignment structured settlement payments (or subsets of those rights) to investors as annuities, be forewarned that acquired structured settlement payments rights are not recognized as annuities or insurance products by the NAIC.
26 U.S. Code § 61 - Gross income defined
(a)General definition Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:
Outright investment made with after tax dollars
If you simply paid $100,000 in 2012 to buy someone else's $198,200 lump sum structured settlement payment due in 2022, you will have to declare the $98,200 difference whether or not you received a 1099.
If you receive a 1099 it may come from the life insurance company if you have a direct assignment of structured settlement payment rights by court order, or it may come from a third-party payment servicer if you invested in a subset of an assignment of structured settlement payment rights.
What if the Structured Settlement Investment Was Purchased in a Roth IRA?
Note however, if the purchase of structured settlement payment rights was made with funds in your Roth IRA, are an asset of your Roth IRA, and the distribution is made after the account has been open at least 5 years, you may qualify for tax-free withdrawals of both Roth IRA contributions and any accumulated earnings.
A Roth conversion is a strategy that allows you to pay income taxes on some or all of your retirement assets today, rather than when you withdraw them in retirement. Certain financial advisers were advising clients to do a Roth Conversion and to use the proceeds to buy factored structured settlement payment rights held in the Roth IRA.
Your eligibility to contribute to a Roth IRA is subject to your level of income. If you file taxes as a single person, you can contribute to a Roth IRA only if your Modified Adjusted Gross Income (MAGI) is less than $144,000 for the tax year 2022. If you are married and file taxes jointly, the IRS allows you to contribute to a Roth IRA only if your MAGI is under $214,000 for the tax year 2022.